10/14/2024

Six months ago, the fourth consecutive upside surprise in U.S. CPI led markets to price in less than 50 basis points of Fed rate cuts for the entirety of 2024.  Although expectations for the path of ECB rates also experienced a downward adjustment, the shift was clearly smaller in scale. Investors began to suspect that the ECB would cut rates more aggressively than the Fed, given the macroeconomic differences between the two regions.

However, over the summer months, the situation changed. As US inflation cooled, markets noticed a shift in the Fed's communication, which became apparent at the Jackson Hole symposium when Powell addressed the risks facing the US labor market. From this point on, investors began anticipating a faster easing process by the US central bank, which culminated in a 50 basis point cut at the September meeting. Currently, the downside risks to the US economy appear to have moderated, while the challenges facing the eurozone in achieving a significant economic recovery have become evident. Consequently, markets are once again expecting the ECB to lower interest rates more quickly than the Fed.

This week is expected to confirm the ECB's shift to a more dovish stance, with a 25 basis point cut in interest rates anticipated. While the Governing Council may have preferred quarterly rate adjustments, the recent deterioration in macroeconomic data has sent a strong enough signal to prompt a faster rate-cutting path. This decision is further supported by inflation, which is currently below the ECB's 2% target for the first time since 2021, and by the easing of underlying price pressures. It also seems likely that the October rate cut will be followed by another one in December.

In contrast, it is becoming increasingly clear that at the Fed's next meeting, the pace of tightening will slow, with a rate cut of 25 basis points, down from 50 basis points in the September meeting. The reason is straightforward: the data we have been seeing indicate that the US economy continues to demonstrate significant strength. Similarly, communications from various Fed members emphasize that risks remain balanced and suggest that any future rate cuts will likely be more gradual.

As we have observed, these changes align with the differing macroeconomic contexts. In the US, after strong September employment data, there was another surprise on the upside, this time in inflation. Core CPI increased by 0.31% month-on-month, driven unexpectedly by the prices of core goods, while inflation in core services slowed modestly. This reading emphasizes that upside risks to inflation remain. Separately, weekly jobless claims surged, but the increase was concentrated in states affected by Hurricane Helene. This reduces the likelihood that last week's weakness signals a fundamental deterioration in labor conditions.

Meanwhile, in the eurozone, recent activity indicators suggest weak growth at best. August retail sales remained lackluster, reflecting ongoing weakness in consumer spending. At the same time, German factory orders continued their downward trend.

In short, it seems that the ECB will lower interest rates more quickly than the Federal Reserve, which is contributing to the euro's increased weakness against the dollar. Whether these expectations persist will depend on the forthcoming macroeconomic data from both regions.